Applying for a commercial mortgage can be tricky and stressful. Many business owners struggle with the process due to unfamiliarity with finance terms. This article will guide you through common mistakes and how to avoid them.
Not Understanding the Different Types of Commercial Mortgages
Many people don’t realise there are various commercial loan options available. Choosing the wrong one can lead to higher costs and stress.
Conventional Bank Loans
Conventional bank loans for commercial mortgages often have terms ranging from 5 to 10 years. Banks usually require a minimum credit score of 660 and a down payment of at least 20%.
Interest rates hover between 5% and 7%, which can affect your monthly repayments. Prepayment penalties might apply if you pay off the loan early. It’s crucial to account for these fees in your financial planning.
SBA Loans
Small Business Administration (SBA) loans are a great option for commercial property buyers. SBA 7(a) loans can provide up to $5 million with terms of up to 25 years. A minimum FICO Small Business Scoring Service (SBSS) credit score of 155 is needed for these loans.
SBA 504 loans cover up to 90% of the purchase price and have terms between 10-20 years. These programmes often require only a small down payment, around 10%. They are government-backed, making them more secure than other loan options in the commercial mortgage market.
Bridge Loans
SBA loans offer long-term stability, while bridge loans provide short-term solutions. These commercial mortgage options have higher interest rates but can finance up to 90% of the purchase price.
Terms range from six months to three years.
Businesses use bridge loans until they secure permanent financing. They are great for quick purchases or urgent renovations. But be cautious of their cost due to the high interest rates involved in these types of loans.
Overlooking the Importance of a Detailed Business Plan
Lenders need to see a thorough business plan before approving a commercial mortgage. A detailed plan showcases projected earnings and strategies, which helps in assessing your capability to repay the loan.
Without this, lenders might doubt your business's potential success and decline your application. The business plan should outline how you intend to use the property and include financial projections.
Giving scant attention to this step can risk your entire mortgage application process. Essential documents such as market analysis, profit forecasts, and detailed budgets are part of what lenders evaluate closely.
Including these details gives confidence that you have thought through every aspect of your venture. This makes it easier for them to approve funding because they see fewer risks.
Ignoring the 5 Cs of Credit in Loan Applications
Ignoring the importance of creditworthiness can lead to loan rejections.
Character
Lenders assess the character of business partners and directors. They check personal finances to gauge financial reliability. A poor credit history can hurt your chances of getting a loan.
Lenders want to see if you are trustworthy with borrowed money.
They also review past business dealings and defaults. If you have had foreclosures or missed payments, expect tough questions. Show integrity and honesty in your application. Providing complete information helps build trust with lenders.
Capacity
Capacity measures a business’s ability to repay a commercial mortgage. Lenders evaluate income and debts to determine the debt service coverage ratio (DSCR). A DSCR of 1.25 or higher is required for approval.
Business financial records are crucial. Provide complete bank statements, both savings and checking, for personal and business accounts. These details show if your business generates enough revenue to cover the loan repayments.
Capital
Capital refers to the funds that a borrower has invested in their business. Lenders want to see significant capital from the applicant. It shows commitment and reduces risk.
Minimum down payments are important here. Conventional loans require at least 20%. SBA loans might ask for only around 10%. The more you invest, the better your chances of approval. Loan-to-value (LTV) ratios also play a role. For commercial real estate loans, expect an LTV ratio between 65% and 80%. This means you need substantial equity in your business property or project.
Collateral
Lenders place a lien on your property when you use it as collateral for a commercial mortgage. This means the a specialist commercial mortgage broker can take possession of the residential property if you default on the loan.
Information about the property's value is essential during this process.
An appraisal must be part of your application to determine its worth. This helps establish the loan-to-value ratio (LTV), which impacts approval chances and terms. Make sure to provide accurate details and documents about your property to avoid issues later.
Conditions
Conditions can affect your chances of getting a commercial mortgage. Interest rates for loans range between 5% and 7%. Loan terms usually span from 7 to 30 years. Lenders look at the current market conditions and economic trends.
High inflation or low property values might impact approval decisions. Ensure you understand these factors before you apply. It helps to stay updated on both local and national financial climates.
This gives you a better idea of what conditions are favourable for borrowing.
Underestimating the Documentation Required
Several key documents are essential for a commercial mortgage application. You must provide tax returns, both business and personal, financial records, and bank statements from the past 3-5 years.
Lenders often require asset and liability statements plus detailed financial profiles of all business partners.
Failure to submit complete documentation can delay your loan process or lead to rejection. Essential paperwork includes third-party property appraisals and comprehensive business plans.
Hard money lenders might focus on property value but still need some basic financial records. Ensure you include rent rolls, schedule of leases, and updates on property upgrades to make your application stand out.
Failing to Compare Loan Offers from Multiple Lenders
Many borrowers make the error of accepting the first loan offer they get. Comparing offers from different lenders can save you a lot of money in interest and fees.
Banks
Banks have stricter eligibility criteria but often offer lower interest rates than other lenders. For example, to secure a conventional bank loan, you need a minimum credit score of 660.
This business loan typically comes with terms ranging from 5 to 10 years. Banks are among the most common business mortgage lenders due to their reputable standing and favourable conditions.
Bank loans can be ideal for businesses that meet the high standards set by these financial institutions. They provide stability through fixed interest rates and clear repayments on your mortgage.
Though their requirements may be tough, qualifying for a bank loan can result in considerable savings over time compared to options like private lenders or hard money loans.
Private Lenders
Private lenders offer flexible terms but charge higher interest rates. They can provide faster loans compared to banks or credit unions, ideal for urgent needs. Hard-money lenders, a type of private lender, specialise in short-term loans with durations of 1-3 years and high fees.
These lenders focus more on the property's value than your creditworthiness. This makes them an attractive option if you have poor credit scores. Yet, it's crucial to compare different loan offers before deciding.
Credit Unions often blend personal service with favourable rates; moving from this point will help avoid mistakes related to ignoring comparative loan features.
Credit Unions
Many businesses overlook credit unions. These lenders offer lower interest rates and more lenient terms compared to private lenders. They focus on low-risk projects, making them ideal for stable businesses.
Credit unions provide commercial loans with favourable interest rates. This can save you money compared to traditional banks or other private lenders. By choosing a credit union, you might also benefit from personalised services and local decision-making.
Conclusion
Knowing what to avoid when applying for a commercial mortgage can prevent you facing obstacles and unwanted situations. Don't forget to create a detailed business plan. Pay attention to the 5 Cs of credit and collect all required documents in advance.
Compare loan offers from multiple lenders, including banks and private lenders, before making your choice. You can also contact our team at Revolution Brokers to get the best information.
FAQs
1. What are common mistakes when applying for a commercial mortgage?
Common mistakes include not understanding the difference between residential mortgages and commercial mortgages, failing to assess your assets and expenses accurately, and neglecting to consider balloon payments.
2. How can I avoid errors with commercial lenders?
To avoid errors with commercial lenders, ensure you have all necessary documents ready, including details about your business loans, lines of credit, and any refinancing plans.
3. Why is it important to understand underwriting in commercial mortgages?
Understanding underwriting is crucial because it helps you know how loan underwriters assess your financial health. This includes evaluating your mortgage debt, inventory value, and overall business tax situation.
4. What should I know about amortized loans versus balloon payments?
Amortised loans spread payments over time while balloon payments require large sums at the end of the term. Knowing this helps prevent surprises during loan origination or refinance processes.
5. Can using a mortgage broker help me avoid mistakes?
Yes, a mortgage broker can guide you through complex steps like dealing with peer-to-peer lenders or crowdlending options for commercial property finance solutions.
